RISK MANAGEMENT EDUCATION WORKSHOP August 23 24

RISK MANAGEMENT EDUCATION WORKSHOP August 23, 24, & 25, 2007 - New York The 21 Century -- Multi-Media and Multi-Functional -- Approach to Risk Management: Using RFD-TV Television, Internet, Interactive CD -ROMs, and On-Site Workshops Brought to you by Agri. Logic, Inc; Farm Credit; New York Farm Bureau; New York Corn Growers Association; Hot Shots Video Productions; ABG, Inc. ; The Practical Planner, LLC; USDA-Farm Service Agency; and with funding provided by the USDA-Risk Management Agency RMA Agreement Number: 06 -IE-0833 -0114 -E 1

Pre-Quiz Handout of 10 Questions Have you seen our Ag Lifestyle TV shows on RFD-TV? (Channels – Direct TV 379 & Dish Network 231) 2

What is Risk? The possibility that something unpleasant will happen in the future. Risk Management: – The practice of managing our life and resources, in a manner that provides an acceptable level of risk. Risk management is everything you do to understand deal proactively with risks. Three issues to consider – Frequency of Loss – Severity of Loss – Overall Dollar Impact 3

Types of Risk Production Risk - Anything that hinders the quantity and quality of your production. (weather, pests, diseases, etc. ) Market Risk - Market uncertainty for your product, price declines, gov’t actions to limit imports/exports, input costs. Financial Risk - Having the ability to pay your cash obligations in a timely manner, to obtain capital and financing, and to protect or grow your equity. Legal Risk - The possibility of being sued, fined, or penalized for violating current or future laws, regulations, or contractual obligations. People Risk - Managing people and disruptions that come from any of the 3 Ds: death, divorce, or disability, which could limit or even eliminate the farming operation 4

Risk Tolerance Risk Attitude: Your desire to seek risk – Risk-Averse – Risk-Seeking – Risk-Neutral Risk Bearing Ability: Your financial ability to sustain a loss. Risk Tolerance Assessment 5

Risk Management Techniques Risk Avoidance Risk Control – Prevention: Lowers frequency (irrigation) – Reduction: Lowers severity (spraying for a visible pest) – Diversification: Lowers both by spreading risk Risk Financing – Self Insurance/Retention – Transfer through Insurance & Hedging 6

Risk Management Agency Overview: – U. S. D. A. & Federal Crop Insurance Corporation (FCIC) – Providing crop insurance since 1938. – Provides reinsurance to private-sector insurance companies that sell and service the insurance policies Subsidy – Premiums set to break-even on losses paid plus a reasonable reserve. Coverage Level CAT 50% 55% 60% 65% 70% 75% 80% 85% 90% Premium Subsidy 1. 00 0. 67 0. 64 0. 59 0. 55 GRP/GRIP Sub. 1. 00 NA NA NA* NA 0. 64 0. 59 0. 55 * 80% & 85% are available outside New York 7

RMA Insurance Products Actual Production History (APH) Plan & GYC – Covers individual’s yield loss: 50% - 75% Cov. Levels – CAT: 50% Coverage Level & 55% Price Election Crop Revenue Coverage (CRC) – Covers individual's yield and price losses Indexed Income Protection (IIP) – Covers individual’ lost revenue; uses county yields to index your production history to determine your Approved Yield Dollar Plan – Specialty Crops – Covers individual’s lost revenue 8

RMA Insurance Products Group Risk Plan (GRP) – Covers county’s yield loss: 70% - 90% Coverage Levels – CAT: 65% Cov. Level & 45% of Max Protection/Acre Group Risk Income Protection (GRIP) – Covers county’s yield and price loss Adjusted Gross Revenue (AGR) – Cover’s individual’s lost revenue from multiple commodities – Coverage based off Schedule F tax form Adjusted Gross Revenue - Lite (AGR-Lite) – Like AGR, but liability limited to $1 million in revenue 9

RMA Insurance Products - Review Individu al Plan Yield Insur ance Revenu e Insuran ce Group Plan APH, GYC GRP CRC, Dolla r, IIP, GRIP AGR, AGRLite 10

Actual Production History Plan (APH) Assume you average 110 bu. /acre, select the 75% coverage level, plant 100 acres, and the RMA price is $3. 50. Your insurance coverage is… • 110 bu. /acre x 75% x 100 acres x $3. 50 = $28, 875 Loss Trigger: • Harvested Yield < APH x Coverage Level You experience a drought and only harvest 6, 900 bushels. Your indemnity payment is… • (82. 5 bu. /acre x 100 acres – 6, 900 bu. ) x $3. 50 = $4, 725 All Examples Assume 100% Share and 100% Price Election 11

Crop Revenue Coverage (CRC) Assume you average 110 bu. /acre, select the 75% coverage level, plant 100 acres, and the CRC Base price is $4. 06. Your guaranteed revenue is… • 110 bu. /acre x 75% x 100 acres x $4. 06 = $33, 495 Loss Trigger: • Harv Yield x Harv Price < APH Yield x Coverage Level x Higher of (Harvest Price or Base Price) You harvest 6, 900 bu. Harvest Prices @ $4. 06, $3. 50, & $4. 50. Your indemnity… • (82. 5 bu. x $4. 06 x 100) – (6, 900 bu. x $4. 06) = $5, 481 • (82. 5 bu. x $4. 06 x 100) – (6, 900 bu. x $3. 50) = $9, 435 • (82. 5 bu. x $4. 50 x 100) – (6, 900 bu. x $4. 50) = $6, 07512

Indexed Income Protection (IIP) Assume you average 1 bu. /acre above the county, and the county expected yield is 109 bu. /acre, select the 75% coverage level, plant 100 acres, and IIP Projected price is $4. 06. Your coverage is. . . • 110 bu. /acre x 75% x 100 acres x $4. 06 = $33, 495 Loss Trigger: • Harv Yield x Harv Price < APH Yield x Coverage Level x Projected Price) You harvest 6, 900 bu. Harvest Prices @ $4. 06, $3. 50, & $4. 50. Your indemnity… • (82. 5 bu. x $4. 06 x 100) – (6, 900 bu. x $4. 06) = $5, 481 • (82. 5 bu. x $4. 06 x 100) – (6, 900 bu. x $3. 50) = $9, 345 • (82. 5 bu. x $4. 06 x 100) – (6, 900 bu. x $4. 50) = $2, 445 13

Group Risk Plan (GRP) Assume the county expected yield is 110 bu. /acre, select the 75% coverage level and 100% of Max Protection/Acre, plant 100 acres, and Max Protection/Acre = $488. Your insurance coverage is. . . • $488 Max Protection/Acre x 100% x 100 Acres = $48, 800 Loss Trigger: • Payment Yield < County Expected Yield x Cov. Level You harvest 10 bu. , but it depends on the county Payment Yield is 69 bu/acre. Your indemnity payment is… • (82. 5 bu – 69 bu)/82. 5 bu x $488 x 100% x 100 acres) = $7, 985 14

Comparison – 2007 Madison Corn 15

Madison County 2007 GRP vs. CAT Max Protection/Acre = $488. 08 & 100 acres Expected County Yield = 110. 3 bu/acre NASS County Yields • ‘ 02 = 99 bu/ac; ‘ 04 = 92 bu/ac; ‘ 06 = 69 bu/ac 16

Adjusted Gross Revenue (AGR) Assume you average $800, 000 in gross revenue, have 3 commodities, and select the 75% coverage level at the 90% payment rate. Your insurance coverage is… • $800, 000 x 75% x 90% = $540, 000 Loss Trigger: • Annual Gross Revenue < AGR x Coverage Level You experience loss and only have $200, 000 adjusted gross farm revenue. Your indemnity payment is… • ($800, 000 x 75% - $200, 000) x 90% = $360, 000 17

AGR & AGR-Lite Issues Provides revenue protection from yield & price declines AGR Requirements – Insurance coverage based on Schedule F tax forms (5 Years) – Amount of Insurance cannot exceed $6. 5 million – Purchase traditional Federal crop insurance when more than 50% of expected income is from insurable commodities (with a reduced AGR premium). – No more than 50% of your allowable incomes from agricultural commodities purchased for resale. – No more than 35% of the expected allowable incomes from animals and animal byproducts. AGR-Lite Exceptions – Amount of Insurance cannot exceed $1 million – 35% income limit from livestock is no longer required 18

AGR & AGR-Lite Issues Cov Min. # AGR erag Pay of Max. e ment Comm Annual Lev Rate odities Income el AGRLite Max. Annual Income 65 75 1 $13, 333, $2, 051, 2 333 82 65 90 1 $11, 111, $1, 709, 4 111 01 75 75 1 $11, 555, $1, 777, 7 555 77 75 90 1 $9, 629, 6 $1, 481, 4 29 81 80 75 3 $10, 833, $1, 666, 6 333 66 80 90 3 $9, 027, 7 $1, 388, 8 77 88 19

MI CO *? ? ? ON SO NG Pasture, Rangeland Forage Rainfall Index and Vegetation Index *Depending on Government Funding 20

Rainfall & Vegetative Indices Rainfall/Vegetative Index background – Index – based on precipitation (Rainfall) or greenness (Vegetation) • Not measuring actual rainfall/greenness or individual production The deviation from long-term normal precipitation or greenness is used to establish the index • SINGLE PERIL COVERAGE – Precipitation/Greenness has a high degree of correlation to forage production – WHY? • Lack of actual producer/industry production data • No consistent and practical methodology for measuring production of the crop 21

Rainfall Index Area of insurance = 0. 25 o grids (~ 12 x 12 miles) 22

Vegetation Index Area of insurance = 8 x 8 km (~ 4. 8 x 4. 8 miles) 23

Rainfall & Vegetation Index Rainfall Index Intervals – Multiple Intervals offered – 6 – Crop Year divided into 6, 2 -month Intervals for each grid – Producers must select at least 2 Intervals Vegetation Index Intervals – Multiple Intervals offered – 4 – Crop Year divided into 4, 3 -month Intervals for each grid – Producers may select more than 1 Interval 24

Rainfall & Vegetation Index Ability for producers to manage their individual risk periods – Correlate to individual growth patterns and production seasons – The Intervals provide for greater reaction to forage reduction events vs. a yearly average Not required to insure 100% of acreage Internet based Coverage Levels: 90, 85, 80, 75, and 70 Sales Closing Date & Acreage Reporting Date: November 30 th Rating: Each grid, Index Interval, and coverage level is individually rated 25

Risk Tolerance: Coverage Levels? 26

APH & GRP: County Yield Correlate? 27

Commodity Marketing Forward Price Contracting 28 Photo Source: USDA/ARS

Forward Price Contracting – Is a tool that agricultural producers of select commodities can use to mitigate a portion or all of their price risk. Hedge – The practice of offsetting the price risk inherent in any cash market position by taking an equal but opposite position in the futures market or with another forward contracting alternative. – The hedger (i. e. a corn producer) foregoes the opportunity for additional profit as a result of increases in the market price for their commodity (i. e. corn), for the ability shift risk of decreases in the price to another entity (i. e. a feed mill). Four general categories of hedging mechanisms are: – – Forward Cash Contracts Futures Contracts Option Contracts Other privately negotiated forward contracting mechanisms 29

Terminology Forward Cash Contract – Obligates the holder to buy or sell an asset for a certain price at a certain time in the future. – Non-standardized written agreement • Terms are open to negotiation (e. g. an agricultural producer and grain elevator manager). • Privately negotiated Futures Contract – Obligates the holder to buy or sell an asset for a certain price at a certain time in the future. – Highly standardized written agreement • Standard quality, quantity, delivery time, and location • Traded only on an exchange (i. e. Chicago Board of Trade (CBOT), New York Board of Trade (NYBT), etc. ) 30

Terminology Option Contract – A written agreement that gives the buyer of the option the right, but not the obligation to, buy or sell for a limited time a particular good at a specific price. – Call Option - An option to buy. – Put Option – An option to sell. Basis – Difference in the local spot (“cash”) and futures markets price for a commodity. Futures Risk – The risk that fluctuations in the level of price in the futures contract will occur. Basis Risk – The risk that fluctuations will occur in relationship between the local cash (i. e. New York) and futures markets (i. e. CBOT). 31

Forward Cash Contract Scenario: New York Corn Producer Cash Market – 250 acres of Corn – 100 bushels / ac. expected yield Futures Market May: Plans to sell 25, 000 bushels of corn in October May: Forward Contract 25, 000 bushels with local Grain Elevator at $2. 83/bu. (e. g. $2. 56 futures price and $0. 27 basis) October: Delivers 25, 000 bushels of corn to buyer. The cash market @ $1. 90/bu. futures price + $0. 25/bu. local New York basis in October: Delivers on grain to buyer and receives the difference in the contracted price and the revenue received from the cash market. 250 acres × 100 bushel per ac. yield = 25, 000 bushels expected production – Hedges 100% of 25, 000 bushels of expected production * NOTE: 100% Hedge is unlikely, but is used for example purposes. Depending on your risk tolerance, production, etc. you should consider hedging 40% - 80% of your crop. Gross Revenue Calculation Revenue from Cash Market: Revenue from Hedging Strategy: ($1. 90 / bu. + $0. 25 / bu. ) × 25, 000 bu. = $53, 750 Futures Price Component: $2. 56 - $1. 90 = $0. 66 / bu. Basis Price Component: $0. 27 - $0. 25 = $0. 02 / bu. ($0. 66 / bu. + $0. 02 / bu. ) × 25, 000 bu. = $17, 000 Total Gross Revenue: $53, 750 + $17, 000 = $70, 750 (Approximately 24% From Hedging Strategy) 32

Option Contract Cash Market Scenario: The same New York Corn Producer May: Plans to sell 25, 000 bushels of corn in October – Hedges 100% of 25, 000 bushels of expected production – 1 CBOT Option Contract is for 1 CBOT Futures Contract October: Sells 25, 000 bushels of corn in cash market @ $1. 90/bu. futures price + $0. 25/bu. local New York basis in October Futures Market May: Buy 5 CBOT December corn $2. 60 Put Option Contracts @ $0. 30/bu premium October: Exercise the 5 CBOT December Put Option Contracts @ $2. 60/bu strike price Assume round-trip trading cost are approx. $0. 01/bu. Gross Revenue Calculation Revenue from Cash Market: Revenue from Hedging Strategy: ($1. 90 / bu. + $0. 25 / bu. ) × 25, 000 bu. = Futures Price Component: / bu. Basis Price Component: $53, 750 $2. 60 - $1. 90 - $0. 30 - $0. 01 = $0. 39 N/A ($0. 39 / bu. + N/A. ) × 25, 000 bu. = $9, 750 Total Gross Revenue: $53, 750 + $9, 750 = $63, 500 (Approximately 15% From Hedging Strategy) 33

Other Risk Management Strategies 34

Other Risk Management Strategies Production Risk – FSA • NAP • Disasters • Emergency Loans – Crop-Hail Insurance – New Technologies (seeds, sprays, precision farming, etc) Production & Market Risk – Diversification: fields, crops, types, non-farm income Record Keeping!!! 35

Financial Risk Obtaining Capital & Financing (Interest rates) – Mitigate by lowering debt-to-asset ratio; have collateral, crop insurance and marketing plan; shop for better borrowing terms and conditions; establish relationships with lenders. Meeting Cash-Flow Needs (short-term) – Mitigate by having liquidity, reducing expenses, lines of credit, insurance for crops, machinery, equipment, etc. Protecting & Growing Equity (long-term) – Mitigate by having insurance for major events: crops, property, liability, heath, disability, and life – During good years, build-up liquid reserves, invest (possibly in non-farm assets), pay down debt. 36

Legal Risk Concern: Risk of being sued. Mitigate by… Structural Entity of Operation – – Sole Proprietor (all risk all reward) Partnership (shared risk and reward) LLC (1 or multiple owners with limited liability) Corporations (Sub S or C having 1+ owners with limited liability) Contractual Agreements – Non-performance: Get it in writing & use trustworthy parties Tort Liability – Neglect or Harm to Person/Property – Review general liability insurance for coverage and exclusions Statutory Laws – lots of them for farming – Labor & Environmental: Have insurance and maintain accurate documentation 37

People Risk Concern: losing key owners/partners/employees – – Managing People Death Divorce Disability Mitigate by having… – Life insurance and disability insurance to offset lost income, hire new employees, and meet cash-flow needs – Heath insurance and long-term care to offset any new expenses – Cross-functional training of employees and owners – Written succession and estate plans 38

Estate Planning Is the process of planning for the final disposition of your life's work. Benefits of Estate Planning – – – Peace of mind for you and your family. The guardianship and care of dependent children. A reduction in estate tax liability. Distribution of assets according to your wishes. An assurance that your business will continue with the least amount of disruption Mitigate by having… – A Will, use Trusts (Revocable Living Trust, Marital Trust, Charitable Trusts, etc) and Gifting 39

Goals - SMART S - Specific - Goals need to be clearly defined and written. . . no room for ambiguity here. For example, 10% return on capital, break-even this year, etc. M - Measurable - Acceptable standards of measurement need to be consistently used for each goal, e. g. bushels, dollars, hours. A - Attainable - It may be exciting to reach for the stars, but accomplishing realistic goals is rewarding. Are you shooting for the highest yield ever or a reasonable average? R - Related - Goals should be written so that they are related to each other and do not compromise your basic values and beliefs. Related goals include moving the operation toward higher returns this year and long-term equity/ownership. T - Tractable - Goals should be established with progressive steps and checked or monitored over time. 40

Implementation Identify and analyze your risks and risk tolerances Establish your goals Evaluate the alternatives available Implement the action plan with your best alternatives Monitor the progress and results Update the plan as needed 41

Need more information? Education Manual RFD-TV (Channels – Direct TV 379 & Dish Network 231) Interactive CD-ROM Online – www. rma. usda. gov – www. agrilogic. com/education Contact your local crop insurance agent RMA Regional Offices 42

Post Quiz Handout of 10 Questions DON’T FORGET YOUR DVD & CDS!!! 43